Repurchasing Sold Assets That Have Deteriorated: The Prior-Sale Safe Harbor Under Reg W

Here is a practical scenario: a bank previously sold an asset to an affiliate with recourse (meaning the affiliate can require the bank to repurchase if the asset goes bad). The asset has since become a low-quality asset. May the bank repurchase it?

Yes, provided the asset was not a low-quality asset at the time the bank originally sold it. This is an important safe harbor. The policy rationale is that the bank’s recourse obligation was established when the asset was healthy, and the bank should be able to honor its pre-existing contractual commitment even though the asset has since deteriorated.

However, if the asset was already a low-quality asset when the bank first sold it to the affiliate, the bank may not repurchase it. The low-quality asset prohibition in 12 CFR 223.15 prevents a bank from purchasing low-quality assets from affiliates, and this prohibition would apply to the repurchase.

This distinction highlights the importance of timing and documentation. Banks that sell assets to affiliates with recourse should document the asset’s quality status at the time of sale, including any examination classifications, to support a future repurchase if necessary.

DM Tip: If selling assets to affiliates with recourse, document the asset’s classification status at the time of sale. Maintain this documentation throughout the recourse period so that, if repurchase becomes necessary, you have clear evidence that the asset was not a low-quality asset when originally sold.